Following Sainsbury's shock profits warning a fortnight ago, Safeway's surprise announcement forced supermarket shares down across the board as some analysts said price-cutting was more likely as supermarkets act to boost flagging sales growth. Safeway was hardest hit with a 27p fall to 362p.
Colin Smith, Safeway's chief executive, said shoppers were "pulling in their belts a little bit more than usual" with a marked slowdown in the last four weeks. Inflation is being pushed down by double-digit deflation in fruit and vegetables, while meat and bakery prices are also falling.
Mr Smith said that if the trend continued, "profits for the remaining eight weeks of the year could be affected".
Though Safeway said a price war was "very unlikely", some analysts said it would take only one of the big four to break ranks to spark another round of price promotions. Asda is tipped as the most likely aggressor.
Safeway's business development director, Steve Webb, said that its announcement might create more price instability in the sector. "We've never been an aggressor but we would be a very aggressive participant if someone else initiated a price campaign."
Nick Bubb, retail analyst at Mees Pierson, described the recent fall in sales as a "blip" but added: "Clearly if this continues the chances of someone launching a major promotion are much higher."
Frank Davidson of HSBC James Capel said the inflation question was serious for the sector and was likely to get worse with prices of meat and milk falling. "These groups need 4-4.5 per cent price inflation just to stand still. These guys are inflation junkies - if they don't get their fix they start shaking."
In a report last month, Verdict Research said a supermarket price war was more likely now than for any time in the last 15 years. It said Sainsbury's might prove the first to crack if its current strategy to improve sales did not deliver results.
Lower inflation and a more competitive food sales environment are likely to make a Sainsbury's renaissance harder to achieve, analysts said.
Safeway's profits warning overshadowed the rest of its Christmas trading statement, which showed that same-stores sales in the five weeks to 4 January were 5.2 per cent ahead of the same period last year. The increase was due to volume growth with inflation contributing just 1.1 per cent. Sainsbury's said two weeks ago that its food price inflation was running at around 3 per cent.
Safeway credited its customer service programmes, its ABC loyalty card and its Harry & Molly advertising campaign for the increase.
Analysts cut their current year profits forecasts for Safeway from around pounds 440m to pounds 432m. Most analysts also shaved about 5 per cent off the 1997- 98 forecasts, with James Capel predicting pounds 445m instead of pounds 470m.
There was no news on Safeway's interest in the Wellworths supermarket chain in Northern Ireland. Though it is understood talks have taken place, any deal is said to be some way off. A deal would value the chain at around pounds 180m.